November 27, 2010

DAVID SKEEL: Give States A Way To Go Bankrupt: It’s the best option for avoiding a massive federal bailout. “When the possibility is mentioned of creating a new chapter for states in U.S. bankruptcy law (Chapter 8, perhaps, which isn’t currently taken), most people have two reactions. First, that bankruptcy might be a great solution for exploding state debt; and second, that it can’t possibly be constitutional for Congress to enact such a law. Surprisingly enough, this reaction is exactly backwards. The constitutionality of bankruptcy-for-states is beyond serious dispute. The real question is whether the benefits would be large enough to justify congressional action. The short answer is yes. Although bankruptcy would be an imperfect solution to out-of-control state deficits, it’s the best option we have, at least if we want to have any chance of avoiding massive federal bailouts of state governments.”

Via the Volokh Conspiracy, where there’s this additional suggestion: “Any law that lets states be bailed out should require them to renounce their state status and revert to being territories, to be reorganised by the federal government as new states. That has the advantage of getting rid of the old, dysfunctional, state government, removing the state and its inhabitants from national influence until they’ve had a chance to learn some wisdom, and being enough of a penalty to make bailouts unattractive to other states.” I see many problems with this approach, but I admire its spirit.

UPDATE: A Wall Street reader emails:

A big part of the hysterical elite reaction to the Tea Party is the justified belief that the outsiders would do everything possible to obstruct a federal bailout of the states and their unions’ pension/benefits funds.

Federalizing all the state workers’ liabilities has long been a unspoken goal of the permanent government.

Hmm. Meanwhile, Jim Bennett emails on state bankruptcy:

Something like it is inevitable. I think there should also be a provision permitting the subdivision of bankrupt states into two or more new states, analogous to the restructuring of companies which often involves spinoff of divisions. No accident that all of the really bad Too Big to Fail states are in the above-average half of the ranking of states by size. California is as big as a middle-sized EU member and acts like it, only with a less competent civil service.

By the way, there is a historical North American example of a state-level bankruptcy and receivership process during the previous depression. They ended up merging it into a larger entity.

It was voluntary, as a condition of a bailout.

Interesting. And reader Stephen Clark writes:

I too admire the spirit of the last VC suggestion you highlighted, if only out of malicious delight. If it ever became a serious proposal or seemed even the least bit likely of becoming reality, I imagine that the old concept of “states’ rights” would gain sudden and renewed respectability in some unlikely places. That alone would be worth the price of admission.